Market Thoughts: Carouselling…

We continue to see sharp rotations in risk assets. Earnings announcements have driven some of it. Current carouselling reflects a narrow market offering traders the opportunity to churn between leaders and laggards. At an index level, going around in circles.

Trading ranges across markets are holding up. Though the abrupt swings we’ve seen under the surface continue. I’d imagine that’s a function of gross and net de-risking as leverage is unwound. Also, reflection on what looks again to be a solid earnings season in the face of creeping AI-doubt.

It’s been a challenging market for active traders. Over the past few weeks, we’ve seen some concentrated risk positions hit hard. In particular hyperscalers, as investors refocus on free cash flow generation. That adds emphasis to why we’ve anchored throughout this year on diversifying higher-beta risk we hold in portfolios.

You can create wealth by concentrating risk. You preserve it by diversifying; then compounding returns. As index levels press higher, investors lose sight of how high they’ve climbed. It’s when ‘bubble talk’ begins to creep into the narrative. Seemingly, the case today.

Investors continue to exercise restraint. It’s deserved in a market where the tradeoff between risk and reward is cloudy. Where earnings are viewed as good, not great. The risk rotations we’re seeing are ultimately healthy. They're painful as they're happening. Investors challenging an ‘everything only goes up’ narrative. So far we’re seeing rotation, not capitulation.

Macro data continues to highlight a steady economy, stable labor markets and—unfortunately for policymakers—sticky (and rising) inflation. Recently released U.S. growth and inflation data a case in point.

Third-quarter GDP grew at an annualized rate of 3.4%, up from a prior 2.2% second-quarter reading. Growth is one of the reasons the Federal Reserve (Fed) chose not to raise rates at its October policy meeting. But that headline strength is deceiving.

Top line growth is being fueled, in large part, by continued AI-buildout. Private investment was up about 10%, driven by IT-equipment investment. Personal consumption came in strong, at an annualized rate of +3.8%. Growth at the expense of savings, because of inflation. Not a great narrative.

The immediate challenge for the Fed is an uptick in inflation. Both headline and core personal consumption expenditure (PCE) price indices were higher: 3.6% and 3.1% year-over-year respectively. That puts a December rate hike squarely in focus; keeping the front-end of the bond curve under pressure.

None of this is (yet) alarming, for an economy in late cycle. Investors got what they wanted, no rate hike. A pause in animal spirits signals awareness that inflation continues to outpace wages. Eventually weighing on economic growth.

The catchphrase “hawkish bias” is with us for a while. Policymakers don’t have a choice; macro data demands it. That argues patience from policymakers and risk-takers alike. Earnings continue to validate what’s gotten us to current market levels. So far, so good.

The rate of change on future earnings and operating leverage will be watched closely. Investors weighing earnings expectations and free cash flow against capital expenditure. Especially investments financed through public markets. The bar for ‘good news’ has rightfully been raised.

Markets are wobbly. Liquidity’s ample. Animal spirits are spirited. But a whiff of risk-taking caution is warranted. Good times can keep rolling. But the current market-psyche pivot is setting us up for more pronounced bouts of volatility ahead.